MILAN/ABU DHABI, Nov 30 (Reuters) - Europe's only commercial maker of military drones, Italy-based Piaggio Aerospace, has lost its sole customer after going into bankruptcy in a setback for Italian ambitions to challenge U.S. and Israeli firms in a fast growing industry.

Piaggio, a unit of Abu Dhabi's sovereign fund Mubadala, competes with firms such as U.S. General Atomic, Northrop Grumman and Lockheed Martin as well as Israel's Elbit Systems and Israeli Aerospace Industries (IAI).

The market for military drones is estimated to be worth between $6 billion and $10 billion in 2018, but analysts say it is set to increase sharply over the next decade.

This month, United Arab Emirates cancelled an order placed through state-owned defence company ADASI with Piaggio Aerospace for eight unmanned P1HH drones, a Mubadala spokesman said, adding the decision was made due to "delays and failures of the agreed programmes".

One source familiar with the matter said the order had been worth 400 million euros ($454 million), a figure which included development costs borne by the Italian company.

ADASI could not be reached for a comment while Piaggio Aerospace declined to comment.

Piaggio Aerospace had already built four of the drones at its factory in the coastal city of Albenga when the cancellation came through, two trade union sources said.

The drones were Piaggio's first production run and were scheduled to be delivered to the UAE air force in January.

Piaggio Aerospace, which also makes executive jets and has a contract for engine maintenance with the Italian air force, recently sought protection from creditors. Its collapse leaves Europe with just one other major drone-manufacturing project, a pan-European consortium called EuroMALE.

TURNAROUND FAILS

EuroMALE is backed by the governments of Germany, France, Italy and Spain through Airbus, Dassault Aviation and Leonardo, but its drones are not expected to enter service before the middle of the next decade.

A meeting over Piaggio Aerospace's future is scheduled on Dec. 7 at Italy's industry ministry, which is expected to hire a special commissioner to run the company.

Leonardo Chief Executive Alessandro Profumo said on Wednesday the state-controlled firm was looking at developments at Piaggio Aerospace, given its important role with the Italian air force and its activities in strategic sectors.

Piaggio Aerospace owes more than 100 million euros to Leonardo for components used in its drones.

Elbit Systems and IAI declined to comment.

Piaggio Aerospace said last week a 2017 turnaround plan had failed to produce expected results and it was no longer financially sustainable. It puts at risk over 1,100 jobs.

Mubadala said it no longer saw the conditions to inject new funds in the company.

Mubadala gave up on Piaggio Aerospace after UAE officials grew angry with Italy's new populist government over a delay in a 766 million euro order for 20 new generation P2HH drones from the firm, three sources told Reuters.

The UAE had pledged to match Italy's P2HH order with another of the same size. The P2HH orders, combined with the UAE order for P1HH drones, was meant to underwrite the firm's turnaround.

But the Italian government, in power since June, has shown little commitment to spend money on new defence equipment, the sources said.

Italy's defence ministry had no comment.

Two sources said the Abu Dhabi government had not really made a serious effort to lobby Rome to press ahead with the Italian P2HH order, still in the development phase.

"Since Piaggio has declared insolvency and filed petition for the extraordinary administration, Mubadala no longer has involvement in the future direction of the business," the Mubadala spokesman said on Wednesday.

"They felt they had been taken for a ride, so they eventually decided to pull away," one source said.